Inflation and yield U. S.

Inflation readings with uncertainties

In my previous note, I concluded that the Fed and the market have different focuses: the Fed cares job creations; and the market cares value of money. That explains the market behaviours we saw today and last Friday.

  • last Friday the labor department reported that new added job in April were well below expectation. The job number confirmed that the Fed’s assessment is right and current low policy rates and asset purchases should stay for long. Market cheered for bad news – logical thinking: inflation low, interest rate to stay low, money to remain cheap, so stock prices jump.
  • Today labor department reported inflation data for April. Headline inflation was 4.2% y/y, 0.8% m/m. Core inflation was 3% y/y, 0.9 m/m. These numbers are all much higher than expected. Market cried by selling off – logical thinking: inflation high, rate to go high, money to be more valuable, so stock prices dive.

The April inflation numbers are embedded with significant uncertainties that can be contributed by

  • The baseline prices in their calculation, which are the numbers in April last year, were significant low due to sudden economic closure. It contributed at least 1% in the y/y inflation calculation.
  • Supply chain tightness due to economy open and shortage of certain materials pushed up their prices.
  • April price increase is compounded by seasonal effect, vaccine progress and lockdown ease up. This reflected in the price increases in hotels and travels, for example.
  • Extended unemployment benefits prompted consumption, and increased bargain power in negotiating salaries when accepting job offers.

I think we can not read too much into a single set of inflation numbers. The numbers in the next few months which are expected to show higher than 2% as well, will be subject to the same uncertainties. I think the Fed is right to focus on job creation. The current inflations, even they are true, are not results from the monetary policies in the past. They are truly “transitory”. Fed actions, if to take, will need at least a year to transmit their effects into the economy.

When the investors take a second look at today’s inflation, they might come back to the market. Maybe very soon.

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